Numi Advisory has advised over 400 clients by providing career coaching, mock interviews, and resume reviews for people seeking jobs in equity research and investment management (full bio at the bottom of this article).

Last time around, we learned why hedge fund case studies matter so much, what to think about before getting started with your own case studies, and why a great case study is your best friend if your pedigree isn’t quite up to the “4.0 GPA at Harvard/Wharton/Stanford and multiple internships at Goldman Sachs” level.

Oh, and there were also some jabs directed at the Occupy movement and The Hobbit, but I guess those are less relevant for interview prep.

We’ll pick up today from where we left off and cover how to research, structure, and present your stock (or other asset) pitch and support your arguments.

You might think this is the “easy part,” but that’s completely wrong – in fact, an inadequate structure and/or research often sink otherwise good investment ideas… along with those $500K+ job offers.

Let’s get back to it as I continue to extract information from our interviewee (don’t worry, I tied him up but he hasn’t been physically harmed yet):

How Many and What Types of Ideas Do You Need?

Q: I’m glad you’re not sick of talking to me yet. So far, we’ve focused on pitching a single stock or other asset and preparing for that type of case study, but is it a good idea to come prepared with multiple ideas?

A: Ideas, yes, full case studies no. I would always show up prepared to speak about at least 2 stocks – when I was recruiting, I always had at least 3 ideas that I could speak about credibly… and ideas where I felt like I would know more about them than the interviewers.

And, of course, if you’re interviewing at a fund that uses a strategy other than L/S equity, you still need at least 2-3 investment ideas that you can speak to.

Yes, the interviewer might understand a healthcare pitch better, but you actually have an advantage if you pitch a consumer retail idea because the interviewer won’t know as much about it.

Q: And what if you’re interviewing with a long-only shop but you want to pitch a short idea? Is that allowed?

A: Again, it’s better to align your pitch with the fund’s strategy, but if this is your best idea and you can explain it well, it’s fine… because the fund can just underweight that company or exclude it rather than shorting it.

True short candidates are very hard to come across, in my opinion, so sometimes this type of response can work in your favor.

You can often just get away with saying, “I understand that you guys are a long-only shop, but I have a short pitch I’d like to tell you about. I think it will give you insights into how I think about investing in general, and with respect to underweighting certain stocks in particular.”

That would make a lot of sense to either a long/short equity fund or even a long-only fund that wanted to exclude this from the index.

Q: Right. What about pitching “Hold” or “Neutral” ideas?

A: If you can pitch any stock, you probably don’t want to pitch a “hold.” But there will be situations where someone asks your opinion of a stock, especially in a case study. If your analysis reveals that potential upside is basically the same as downside – i.e. “neutral” – then that’s your view and you’ve got to stick with it.

Odds are that 9 out of 10 companies are going to be priced to perfection or near perfection because there are a lot of smart people out there analyzing them and trying to make money… but with these case studies, you’re looking for that one company that’s priced imperfectly.

How to Research Stocks… and Other Assets

Q: So, in short, pick a company you know well that others don’t, find something that’s priced imperfectly, and try to align your pick with the fund’s strategy but don’t kill yourself over it if it doesn’t quite match.

A: Yes. And please, don’t use Apple, Google, or Facebook in your pitch.

Q: Let’s jump into the actual business of researching stocks and/or other assets that you might potentially pitch in interviews.

Many candidates only have 2-3 days or less to research and decide on an idea, and they don’t know where to start.

What would you suggest?

A: First off, you may want to reevaluate your career if you want to move to the buy-side but you don’t already have stocks or companies you follow or want to invest in.

If you really don’t have anything, start by picking an industry that you know something about and reading research and commentary on it, and look for companies that might be worth analyzing further… or you could start with a “big trend” in a certain industry and find companies that are well-positioned to take advantage of it.

With the right argument and support, you could make almost anything into a stock pitch for use in your case study – but if you don’t already have something, you need to start by spending at least a few hours reading up on the industry and looking at similar companies.

Q: Right, those are good points.

But what if it’s an unfamiliar company (i.e. they tell you the specific stock to analyze) and you don’t have much time to research it?

A: First, you need to lock down your investment process before you even begin interviewing. Over time, you should develop your own process, but that often just comes with time and experience.

However, reading some of the “classics” can help you develop your investment process or style. For me, some of the books I rely on for my own process include The Intelligent Investor by Ben Graham, Margin of Safety by Seth Klarman, and Competitive Strategy by Michael Porter.

But if you don’t already have a process, you should go through these steps to analyze an unfamiliar company:

Review the SEC filings (or just the corporate filings if you’re pitching a company outside the US) and the company’s most recent investor presentation.

Then, identify the 2-3 key drivers of the stock. In some sectors, this is easy: many retail companies, for example, will be driven by factors like total square feet, sales per square foot, and same-store sales growth. These can be more difficult to determine in unfamiliar industries.

Then, read several equity research reports to figure out the “consensus thinking” (no, do not rely on these for your own thesis – these are strictly for background reading / information).

Once you’ve done all this, start your field work – hedge funds value primary research a lot, and you can learn far more by speaking with credible industry sources than you ever could by reading analyst reports.

Q: So let me stop you right there. With this “field work,” what exactly do you recommend doing?

Should you look up key customers and suppliers in a company’s filings and then call them?

A: Absolutely. And don’t stop there – contact competitors, customers that might have switched to competitors’ products or services, company management, and so on.

Then there are industry publications, independent surveys, and interviews with management at other companies.

Also look at filings and earnings call transcripts from competitors, customers, and suppliers – yes, that’s a lot to go through, so maybe focus on the top 2-3 in each category… but always look to see if someone else is contradicting what this company’s management is saying.

If that’s the case, someone must be lying. You will definitely impress your interviewer if you can identify such situations.

Sometimes, buy-side equity research analysts know a hell of a lot more than sell-side analysts so also consider asking them for their views as well.

How do you actually go about finding all this information? Do you just look for keywords in the company’s filings and then search for phone numbers online?

A: You could try that, though I’m not sure what your success rate would be.

I used a different strategy: I went on LinkedIn and found people working at the company I was interested in and said, “I’m doing some research on this company. I’d really appreciate 15 minutes of your time to pick your brain on a couple of things. I’m early in my career and am genuinely curious to learn more about your industry.”

People tend to be inclined to help if they see that you’re young, curious, and humble.

Now, you may have to write to 10+ people before you hear back from a couple of them.

But if one of them is a senior design engineer from a competitor and one is a former CTO somewhere else in the value chain, those are two pretty important people you could be talking to.

Another benefit is that you can keep going back to your network in the future, and effectively you’re both networking and preparing for interviews at the same time.

Footnoted!

Q: Awesome. Networking and potentially making money at the same time, I like this.

So let me go back to one of your earlier points on reading through the SEC (or other) filings.

What should you look for in those? Are you mostly looking for items in plain sight or those that are tucked away in dusty corners?

A: First, you should never overlook the “Risk Factors” section of the filings. This section effectively contains all the legal disclaimers that could derail an investment in the company.

Some of the language may seem “boilerplate,” but pay special attention to anything that may seem unusually specific to a particular company.

I also recommend a book called Financial Shenanigans – they go through tons of examples of how companies manipulate their financial statements, hide or disguise important information, and generally try to mislead you.

There are case studies of Enron, Worldcom, and other companies that have manipulated their financial statements into bankruptcy and financial ruin.

Here are some things I look for, all of which you can search for simply by pressing Ctrl + F in the filing and then entering the keyword:

Changes in Accounting Policy

Changes in Revenue Recognition

Changes in Inventory Policy

Off-Balance Sheet Liabilities

These items don’t necessarily mean that a company is committing fraud or hiding what it’s doing, of course, but they do indicate that it’s worth a closer look.

Then there are other categories that take more work to find:

“Creative” revenue – Enron “increased” revenue from $10B to $100B at the fastest rate ever recorded in history, if you overlook how it was all fake

Shifting around cash flows inappropriately

Hiding or shifting expenses or losses

Boosting revenue with one-time gains or by recognizing it too early

Showing misleading metrics (Groupon!)

Q: Should you use footnoted.com? They have a paid service where they go through a lot of companies’ footnotes, look in the filings, and see if there’s anything fishy.

It’s amazing what companies disclose there that they effectively just “hide” from people.

A: Potentially, yes. You definitely need to learn how to go through filings and footnotes on your own, but if you’re in a rush or need to look at a bunch of companies, a service like that could be a huge time-saver.

That’s why experience matters so much in this process – the only way to get really good at pitching stocks and making investment recommendations is to do it a lot.

Over time, you’ll also develop your own processes for analyzing stocks.

Q: Yeah, so I think some of these points are more intuitive than others.

Everyone knows how to describe a company (I hope), so I’d rather focus on how to make your recommendation, present your thesis, and address the catalysts and risk factors (we’ll go through the valuation and putting everything together in Part 3).

Any initial thoughts before we go through those?

A: Actually, let’s play a game.

Q: What?

A: Let’s say that we play a coin toss game, and it costs you $10 to play every time. If it’s heads, you win $50, and if it’s tails you get nothing.

Q: This sounds great, I’m going to sign up and start playing right away.

A: OK, so now let’s say you’ve played and flipped the coin ten times and it’s tails every single time. So far you’ve paid me $100 and you’ve gotten nothing out of it.

What do you do on the 11th coin flip? Keep playing or quit?

Q: At this point, I think I would assume that the coin is not fair and stop playing.

A: Well that could be the case… but if the coin is fair, of course, probability tells you that in the long-run you have to make the bet and play again because the expected value of each coin flip is positive.

This “game” is essentially what you do as an investor all day – you have to find these types of asymmetric risk/reward profiles and then, after you’ve placed your “bet,” figure out whether or not “the coin is rigged.”

So that is what you need to think about when structuring and presenting your case study: have you found an opportunity where the expected value is substantially positive, even if “the coin seems rigged” in the very short-term?

Q: That’s a great way to put it. Did you want to add anything else to the structure before we delve into each section in more detail?

I preferred to do write-ups of my recommendations because they can be more detailed than slides… but you could be an overachiever and do both, if you have the time.

Always be able to back up all your numbers – ideally through primary research or other industry sources.

Only incorporate sell-side research for market data or to get a view of the “consensus” so that you can explain how your own view is different.

We’ll address this one in Parts 3 and 4, but you always want to think in terms of risk management: “Even if this company’s stock price tanks, what is the worst that could happen to me? And how can I hedge against that?” Sometimes you can address these points in the valuation section.

The Strength of Your Recommendations

Q: All great points… so moving into the structure now, how important is it to quantify that “asymmetric risk profile” in your recommendation in the beginning?

In other words, should you say, “There’s a 75% chance it’s going to go to $30 a share, but only a 20% chance it’s going to fall to $15 a share” – or is that too aggressive?

A: I would not recommend offering up numbers that specific, because a thoughtful interviewer will then turn around say, “How did you come up with the probabilities?”

And then what are you going to say?

It might actually work against you to be super-specific like that; there’s precision and then there’s accuracy, and a trade-off exists between the two.

Q: OK, so then what would you recommend saying in a recommendation in the beginning? Can you give us an example?

“I recommend shorting Retailer X, which currently trades at $45.00 per share, because it’s overvalued vs. peers by approximately 20-25%, its key metrics such as sales per square foot have been stagnant despite rising valuation multiples, and the company has had increasingly poor transparency on many of these metrics over the past few years.

Catalysts to push down its stock price in the next 6 months include the expiration of key re-seller agreements with 3 of its top 10 vendors and its first earnings results post-acquisition close of a smaller retailer last year.

Investment risks include potentially better-than-expected integrated company results, as well as faster-than-expected market growth, but we could mitigate those by longing one of its competitors to reduce potential losses from unexpected market growth.”

Catalysts Calling

Q: Thanks! I hope everyone is taking notes.

Now onto the next section of interest, the catalysts – you’ve mentioned a couple examples such as the renewal of key agreements, earnings results, and so on.

What else might qualify as a good catalyst?

A: Sure… a catalyst is any event that could make a meaningful impact on the stock.

It doesn’t even have to be an upcoming or planned event necessarily – it could just be a potential event in the future. Examples:

New product releases

New stores opening

New competitors emerging or existing competitors changing their strategies

A company pouring too much money into a business segment that investors don’t like – in that case, the catalyst might be the potential divestiture of that segment

Positive clinical trial data for a biotech or healthcare company – you might have an educated guess after reading literature and speaking with doctors

Share repurchases, debt or equity issuances, and M&A deals

In a sense, catalysts mean that all investing is “event-driven” to some extent.

Without a catalyst, the price will not move in any particular direction – so you need to think about these quantitative and qualitative factors that might move the share price.

Some stocks can stay underpriced or overpriced for years unless something forces the market to understand that it’s priced incorrectly.

Q: So what makes for a “good” catalyst vs. a “bad” catalyst?

A: Anything that’s too far into the future would not be a good catalyst. The stock market has a short-term bias, so most companies will not trade on products that might be launched 5 years from now.

You want to focus on what will happen in the near-term – a year or less, or the next few months, or something in that range.

Sometimes, candidates also pick catalysts that are too generic or that won’t make a significant impact on the company’s stock price.

Yes, the economy entering or exiting a recession could make a difference… but that’s a very generic “catalyst” since it will affect all companies.

If you want to state something like that, you need to explain how specifically it will affect the company you’re analyzing (e.g. consumer spending may fall by 3-5%, which will reduce same-store sales by X%, which will push down the company’s revenue and EPS by Y%, resulting in a potential stock price decrease of Z% if current valuation multiples stay the same).

Risk Factors and How to Mitigate Them

Q: Awesome, thanks for those tips. I’m going to skip the Valuation section for now and treat that separately in Part 3. Let’s move into the “Risk Factors” section next.

How do you think about risk factors, and what are the main categories?

A: The main categories are:

The economy as a whole

The overall market / industry this company is in

Company-specific factors

You should almost always start with company-specific factors first because an argument based on the overall economy is usually too generic – if you want to bring up those types of factors, you have to explain how they’ll impact company-specific metrics, which will in turn impact its valuation.

A bad argument would be: “We think taxes are going up, so consumers will spend less and the company’s sales might fall.”

A better argument might be: “We think taxes are going up, so customers especially in segment X may spend Y-Z% less and as a result, supplier A will not be able to fill as many orders, resulting in potentially higher COGS for the company and reduced margins, even though its own direct customers might still be spending at their current levels.”

Q: Great. And what about company-specific risk factors?

A: Those could be almost anything because they depend on the company and its key drivers. A few ideas:

Market Size – Is the total addressable market bigger / smaller than expected?

Pricing – Is the company under pricing pressure? Or can it raise prices regardless of competitors or industry trends?

Key Drivers – What do the company’s key operating metrics look like? Have they been trending up, down, or not changing?

Acquisitions – How have they performed? What will the company do in the future?

Partnerships – Are any suppliers, customers, or partners on shaky grounds with the company?

Financials – Are the company’s key ratios changing as you’d expect? For example, CapEx growth or expense growth that’s out-of-line with revenue growth is usually a red flag.

Your job is to pick the most important risk factors and explain why, although they could result in your prediction being wrong, you don’t think that will happen – or, how you could hedge yourself via protective options or investments elsewhere.

Keep in mind that the risk factors also depend on your investment recommendation – positive factors would be a risk for a “short” view, while negative factors would be a risk for a “long” position.

Q: Thanks for explaining that. I think options and other investments are commonly cited as ways to mitigate risks, but are there other ways to do it?

A: Sure. You could also mitigate risk by pointing to the company’s financials and especially anything on its Balance Sheet that could be sold in the future.

For example, let’s say that a company is trading at around $10.00 per share and it has cash plus other tangible assets that are worth the equivalent of $5.00 per share.

In that case, sure, the stock price could still fall by 50% if the worst happens, but you’re unlikely to lose all your money because of the company’s Balance Sheet (unless the company’s management team is seriously value-destructive or otherwise insane).

The point is to show that you’ve thought through these risk factors – not that you know exactly how to hedge against all of them 100%.

Q: Great. So now let’s jump back into the valuation and modeling part and how to put all this together …

Numi Advisory has advised over 400 clients by providing career coaching, mock interviews, and resume reviews for people seeking jobs in equity research and investment management. With extensive investment experience in equity research and private equity and now working as an analyst at a long/short equity hedge fund, Numi has unparalleled insights into the recruiting process and advancing on the job.

Numi customizes solutions to each client’s unique background and career aspirations, and teaches clients the most efficient and impactful methods to achieve successful results on their career search. He has helped place over 50 candidates in leading buy-side and sell-side jobs. For more information on career services and client testimonials, please contact numi.advisory@gmail.com, or visit Numi’s LinkedIn page.

Comments

I have a Masters degree in Applied Math from a top 5 US university. Currently working in an asset management firm as a software developer since June 2012. I’m interested in research / portfolio management roles, either in a Hedge Fund or in an Asset management firm.

Though my current company does allow people to move from 1 role to another, I have spoken to a lot of people within the firm & I don’t think I will be able to move from my current back-office position into a front-office role.

As a result, I am considering doing an MFE program (Note: I already have a Masters degree in Applied Math from a top 5 US university. My undergrad is in Computer Science from China.)

1. Do you think MFE is the right step for me?

a. If “yes”, then… Since my undergrad is in Comp Sc & I am currently working as a s/w developer, do you think I will be able to make a transition into research / portfolio management roles after the MFE, or will I still be looked upon as a software developer?

b. If “no”, then what should I do to move from my current software role into a research / portfolio management role ?

1. If you have only been working less than 1 year, yes, an MFE will help if it’s from a top school.. but you need solid work experience such as an internship to back it up.

a. You really need to get some type of internship even at a local firm during/before the MFE program and/or develop an investing track record on your own… show them the numbers and that will convince them that you’re serious about making the change.

I have admissions from a number of top MFE pgrms, but am mainly considering the cmu (NYC campus), berkeley and ucla programs. Would you suggest may one program among these, given my educational background, work ex and career goals ??

Also, do you think I can make a transition without having to go thru an MFE program at all ?

Not familiar with all of those programs but maybe someone else who is can weigh in… the NYC campus of CMU may give you an advantage just because it’s NYC and that makes networking easier. There aren’t as many funds on the west coast so the others may not be as good.

You might be able to transition in without the degree, but only if you can point to an audited investment account or something else that proves that you have been trading for years and have a strategy that works well.

Christie, adding to our previous responses to your questions, I’ve taken a look at the questions you have posted on M&I. I understand you really want to break into a front office role in a HF, and we appreciate your enthusiasm and interest in our site’s resources. What is it about working in a front office role at a HF that interests you? What drives you to break into the industry and are you really good at trading/understanding the stock markets? I think these are questions you may want to sort out clearly before you interview. Just a thought.

Amazing post, I’m really looking forward to parts 3 & 4. I just had one question, I understood that might going to be covered in the upcoming parts but what’s the impact of risk management solutions on your pricing/recommendation? Does it have an impact or is it just better to have a risk management plan when you come up with the investment idea?

The interviewee talked about the worst that could happen (I assume we’re talking about Var here), would the risk management/hedging part of the recommendation be more significant in some kind of HF (quant fund, more exotic strategies)?

Risk management is probably more important if the fund uses a more exotic and/or quant-focused strategy so you would have to come up with something more in-depth. I can’t speak to those in-depth because I don’t know the strategies as well, but for a quant fund you might have to come up with some type of additional algorithm or heuristic to risk-manage your main strategy.

For L/S equity, risk management is basically just, “Can we use another investment and/or call/put options to hedge ourselves against losing everything? Or does the company’s Balance Sheet offer built-in risk management because the liquidation value is relatively high (if it’s a long pick)?”

Very useful post and I’m looking forward to the rest of the series. If instead of giving you a stock to pitch or to allow you to choose a stock to pitch they ask you something like: Given a 1 year horizon where would you invest £100? It can be in any region and any asset class.
How would you go about to answer this question?

Thanks! For that type of question I would just ask for more about the person’s goals, such as risk tolerance, income vs. capital appreciation, and any other preferences and then match the investment to what they’re looking for. They probably don’t want you to see anything as specific as an individual stock for that one.

You should probably also inquire about transaction costs. £100 is not a lot of money, so investments with high fixed transaction cost are not option for a one year investment horizon. Better to cover your base than falling itno such a trap.

Unrelated question here, but it’s quick and I was hoping you could provide some insight:

How do investment banks view internships abroad, especially in Latin America. I am a sophomore considering an investment banking internship in Columbia for this summer, but I’m concerned that it won’t count for much because the accounting procedures used are different. Does that matter? Or does the experience from working aboard in IB offset this (solely from a IB recruiting standpoint)?

Since you’re a sophomore only, I don’t think the geographical location matters as much. If you want to go abroad, do so now. Your IB experience in Columbia will be interesting to add on your resume, and I believe it will help you obtain a summer internship in your 3rd year. Some groups with Latam focus may find your experience in Latam more useful than other groups. In your junior year though, it will be more important that you intern in a location where you want to work in after graduation.

Thanks! App: we are going to create a better mobile theme for the site, but probably not a full app. I would like to at some point, but there are about 50 other ongoing projects I’m juggling right now and it’s lower ROI than some of the others.

1. I’d suggest you to form a pitch that you are most comfortable talking about (in terms of the industry and strategy). If you know both very well, it wouldn’t matter if the interviewer knows the subject or not because your knowledge and passion will come across in the interview. Obviously, if the strategy corresponds to the fund’s strategy, you may appear as a more suitable candidate. If you can form a pitch in the same industry and strategy as the fund, and you know the two very very well, I’d choose this option because you can give the interviewer the opportunity to “resonate” with you and get the conversation going

1. I recently had an interview with a mutual fund company for a junior equity researcher position. If I get the position, is the payscale for mutual fund researcher == pay for hedge fund investment analyst (=200-300K) ?

2. The next step in the interview – The interviewer said that they will assign me a company for which they will ask me to do a “model”. I am not sure what “model” this could mean. Do you have any suggestions ?

I have to pitch a fixed income security to an investment committee business school class in 5 days, and I have never pitched fixed income (only equities in the past.) Without my sounding like an idiot, could you please run through a brief structure of how one would pitch fixed income? I can’t seem to find any examples, while stock pitches run rampant all over the web…and how I would do a valuation on that as well?

I recently prepared a stock pitch on a company and sent it, by agreement, to one hedge fund manager as a part of informational interview. His comments back were not very positive, noting that my valuation was merely based on earnings growth and not on new product cycle or improving competitive environment, etc. (FYI, the pitch was on the stock that had a 30% drop over 6-8 months ago, yes it was a tech stock..). I responded to his comments noting that I did note competitive environment and new product cycle (outlining what and where they were). He did not respond back.

A couple of weeks later I met him at a networking event and he (talking in a group of people and not directly with me) said that he gets a lot of stock pitches that he breaks in bits and pieces (see the first paragraph), and that to his surprise not many people follow up with him after that. (Sounds like a comment directed at me..). Then he changed the topic..

So, the question is whether it’s a lost cause or should I email back asking if he had a chance to take a look at my responses to his comments; or what other steps can I take to develop a better relationship with this guy (get a job!), send another pitch, ask for some sort of other feedback, etc?

Yes I would follow up with him by calling and emailing him. I wouldn’t send him a pitch again unless you have some star idea which is different from the one you sent him. Contact him first and see how his response is.

Nicole, thank you very much for your advise! I did email the portfolio manager back, and he responded and actually agreed with some of my responses to his comments.

You’ve been nothing but help so far, and I wanted to ask another question, if that’s alright with you. Would you recommend a way to smoothly transition from the discussion about my research, that I had with the portf. manager, to an actual internship/position conversation?
I’ve obviously thought of emailing him and asking whether his firm would be willing to make an internship opportunity (even if unpaid) or have any openings in the analysts pool, etc. This is more of a direct approach. I was wondering if you had any examples or suggestions of how to approach this transition that you’ve seen work for other people?

FYI, I currently work in M&A transaction advisory – financial diligence. I’m also a level III CFA candidate.

Yes I’d email him and perhaps set up a time to have coffee/chat. Being direct is useful because the PM probably doesn’t have too much time and its best to be straight forward, assuming you’ve developed solid rapport with him. I’m not quite sure about unpaid internship since you’re already working, though I’d ask him for his thoughts to transition into his industry and potential opportunities at his team